Surprise S&P Move Sends European Markets Lower

European stocks, bond futures and the euro were sent reeling Tuesday by the shock warning from Standard & Poor's that it might downgrade euro zone countries en masse if no credible plan to solve the debt crisis emerges at a summit this week.

The unprecedented warning also brought to a halt a rally in global equities that began last week and had continued on Monday, with the MSCI world equity index down 0.6 percent.

European stocks as measured by the FTSEurofirst 300 opened nearly 0.7 percent lower, off a five-week high struck in the previous session.

S&P appear a bit like a comic book villain. You can almost hear them shouting, 'we will destroy you all ? ha ha ha ha,' said Gary Jenkins of Evolution Securities.

In the debt market the news sent December Bund futures 21 ticks lower at 134.61, but benchmark 10-year yields were flat at 2.16 percent.

The euro saw a decisive move lower against the dollar, falling 0.4 percent to around $1.3351. But given most investors were already fearful about the prospects for the single currency, the risk of a massive sell-off was seen as limited, for now.

DOWNGRADE THREAT

S&P said it had told 15 of the 17 euro zone countries, including Germany, France and four others with the top AAA credit rating, that it might downgrade them within 90 days, depending on the outcome of Friday's summit.

The warning took the sheen off a Franco-German agreement, which the two nation plan to put before other member states on Friday, to impose budget discipline across the currency area through European Union treaty changes.

Elsewhere, the IMF approved a 2.2 billion euro ($3 billion) tranche of aid for Greece which was seen as taking the threat of an imminent default off the table. While the Reserve Bank of Australia, citing Europe's woes as a key factor, cut interest rates by 25 basis points and left the door open for more easing.

The RBA move put perceived riskier currencies under further pressure, with the Australian dollar itself falling nearly 1 percent to near $1.016.

Commodities, particularly those most sensitive to industrial demand expectations, were mostly lower.

Standard & Poor's said ratings could be lowered by one notch for Austria, Belgium, Finland, Germany, the Netherlands and Luxembourg, and by up to two notches for the remaining nine placed under review, including currently AAA-rated France.

S&P's warning came after a Franco-German initiative, to be discussed at the Friday summit, to impose budget discipline across the euro zone through treaty changes [ID:nN1E7B41IQ].

If Germany loses its triple-A status, there could well be forced selling of Bunds, and Treasuries and Gilts will be the beneficiaries, said a trader.

There's also the EFSF (euro zone rescue fund), if France and Germany are downgraded it definitely loses its triple-A rating.